Dynamics of Business and

Economics

Dr.R.Parameshwaran
Professor & Head
Department of Mechatronics Engineering
Kongu Engineering College
Perundurai

1
 Nature of Business
• A business tries to earn Tangible Goods
a profit by providing Automobile
products that satisfy Computer
people’s need. Loaf of bread
What is a product? Television
Goods or service with
tangible and intangible Services
characteristics that Dry cleaning
provide satisfaction and Photo processing
benefits. Sometimes Checkup at doctor’s
product can also be an Movie star performance
idea.
2
 GOAL OF BUSINESS
• Profit organizations:
Earn a Profit - The
reward for the risks that
businesses take in
providing products.
• Non-Profit
Organizations- provide
goods and services but
do not have the
fundamental purpose of
earning profits.

3
 Q E
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o
p p
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Maintaining Profitability

Management skills
Profitability
•Planning
•Organizing
•Controlling
•Staffing S
o
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i
B
u
s

•Directing
a
l
i
n
r e
e
s s
p s
o
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s e
i
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i h
l
i i
t c
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s

Finance
Marketing Expertise • Skills to maintain fund
•Products • Expanding its operations
•Price • Maintaining day to day operations
•Promotion
•Place(Distribution) 4
People and activities of Business

5
The Economic Foundations of Business
Distribution of resources for the
production of goods and services
within a social system.

Resources
• Natural resources (land, forests, minerals, water)
• Human resources (labor)
• Financial resources (capital)

6
 Economic Systems
How a society distributes its
resources to produce goods and
services.
Three Important questions :
1. What types and quantities of goods/services will
satisfy consumer needs?
2. How will goods/services be produced? By whom?
With what resources?
3. How are goods/services distributed to consumers?
7
Economic Systems….

Communism

A society in which the people

without regard to class, own all Everyone contributes
the nation’s resources. according to ability and
• China receives benefits according
• North Korea to need
• Cuba
8
Economic Systems…..

Socialism

System in which the government Govt.owned:

owns and operates basic industries Postal
but individuals own most businesses. Telephone
• Sweden Transport
• India Banking
• Israel Health care
Some Manufacturing (Maharatna
& Navaratna companies)
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Economic Systems…..

Capitalism

Free Enterprise – individuals own and operate majority of

businesses providing goods and services
• United States
• Japan
• Australia
• Canada
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Economic Systems

Pure Capitalism
Modified Capitalism

Free Market -- All economic decisions are made without

government intervention (pure capitalism)

Government intervenes and regulates business to some

extent (modified capitalism)
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Economic Systems

Mixed Economies

No country practices pure capitalism or pure

socialism/communism. Economic systems
contain various elements of government
intervention.
12
FREE ENTERPRISE SYSTEM
Rights
• Individuals – have the right to own property and to
pass this property on to their heirs.
• Individuals & businesses – right to earn profits and
to use the profits as they wish, within the constraints
of their society’s law and values.
• Individuals & businesses – right to make decisions
that determine the way the business operates.
• Individuals- right to choose what career to pursue,
where to live, what goods and services to purchase
and more
13
Comparison of Communism, Socialism, and Capitalism

14
Supply & Demand

Distribution of resources and products

determined by supply and demand

Demand : number of goods/services consumers

buy at given price at a specific time

Supply : number of products businesses will sell

at different prices at a specific time
15
 Forces of Supply & Demand

Price at which number of products supplied equal amount of products

consumers are willing to buy at a specific time = equilibrium price

16
 Nature of Competition
Rivalry among businesses for consumers’
money.

Pure competition – many small businesses in same product

market (Agri goods). Price is determined solely by supply &
demand.
Monopolistic competition – small number of businesses little
difference in products (Soft drinks). Businesses have some
power over pricing.
Oligopoly– very few businesses selling a product (Airlines
industry). Businesses have full control over pricing.
Monopoly- only one business providing a product (electricity,
nature gas suppliers, business based on patents obtained) 17
Economic Cycles and Productivity
Expansion and Contraction

Economic Expansion – economy is growing and

consumers are spending money
Economic Contraction – spending declines,
layoffs, economy slows down
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 Economic Cycles terms
•Inflation– condition characterized by continuing
rise in prices
•Recession– decline in production, employment,
and income
•Unemployment– % population wants to work
but unable to find jobs
•Depression– unemployment very high;
consumer spending low; business output sharply
reduced
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Overall Unemployment Rate

20
 Measuring the Economy
• Gross Domestic
Product (GDP) – the
sum of all goods and
services produced in a
country during a year

https://www.imf.org/external/datamapper/NGDP_RPCH@WEO/OEMDC/ 21
ADVEC/WEOWORLD
Evaluating Our Nation’s Economy

22
23
 Trade balance of India

CPI of
India

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GDP PER CAPITA

Inflation rate

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Entrepreneurship
Risk, innovation, creativity, reward

Entrepreneur- An individual who risks his or her

wealth, time, and effort to develop for profit an
innovative product or way of doing something

Bill Gates
Michael Dell
Steve Jobs
Frederick Smith

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 Founder(s): Bill Gates & Paul
Allen
College: Harvard University

Founder(s): Michael Dell

College: University of Texas at
Austin
College: Harvard University
Founder(s): Mark Zuckerberg, Dustin
Moskovitz, Eduardo Saverin, Andrew
McCollum & Chris Hughes

Founder(s): Larry Page &

Sergey Brin
Founder(s): Jerry Yang & David Filo College: Stanford University
College: Stanford University
Jul 29, 2025
 ECOSYSTEM IN INDIA
Indian Govt to spend $75M on startup ecosystem development
 Digital India ; Make In India (2014)
 Skill India; Smart Cities Mission; Stand Up India, Start Up India
(2015)
 ATAL INNOVATION MISSION (AIM) – NITI Aayog
(https://aim.gov.in/index.php)
 MHRD’S Innovation Cell (MIC) (https://mic.gov.in/mic/)
 Atal Ranking of Institutions on Innovation Achievements (ARIIA)
(2018) -MHRD
 Institution’s Innovation Council (2018) – MHRD
 Atal community innovation centre (2019) – AIM

Tinkering labs- schools

Fab labs
TBIs , Startup village
Jul 29, 2025
Ethics & Social Responsibility

Business reputation depends on profit AND

ethical conduct and responsibility

Volkswagen crisis – CO2 emission norms violation

Satyam computers - a corporate scandal that worked in India in 2009 where
chairman Ramalinga Raju confessed that the company's accounts had been falsified

Emission Standards
Global Warming – reached 9 tipping points
Going “Green”
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BASIC CONCEPTS AND
PRINCIPLES

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 Economics - Definitions
• Derived from Greek work oikos (house) and
nomos (custom or law)
• Adam smith (1723-1790) - Father of
economics- “…an enquiry into the nature and
causes of the wealth of nations”
• Alfred Marshall (1842-1924)- “…the study of
mankind in the everyday business of life”
• Lionel Robbins(1898-1984) – “ the science
which studies human behaviour as a
relationship between ends and scare means
which have alternative uses” 31
 Economics Defined….
• “ as a body of knowledge or study that discusses
how a society tries to solve the human problems of
unlimited wants and scarce resources”
• “ is a Social science since it deals with the society
as a whole and human behaviour in particular,
and studies the production, distribution, and
consumption of goods and services”.
(Study of how individuals and societies deal with
scarcity)

32
 Basic Assumptions
• Ceteris Paribus
– Latin phrase
– “With other things (being) the same” or “all other
things being equal”.
• Rationality
– Consumers and producers measure and compare the
costs and benefits of a decision before going ahead.
– Involves making a choice that gives the greatest
benefit relative to cost.
– Firms aim at maximizing profit and minimizing the
cost while consumers aim at maximizing utility and
minimizing sacrifice.
33
 Types of Economic Analysis
• Micro and Macro
– Microeconomics (“micro” meaning small): study of the
behaviour of small economic units
• An individual consumer, a seller/ a producer/ a firm, or
a product.
• Focus on basic theories of supply and demand in
individual markets
– Macroeconomics (“macro” meaning large): study
of aggregates.
• Industry as a unit, and not the firm.
• Focus on aggregate demand and aggregate supply,
national income, employment, inflation, etc.

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 Types of Economic Analysis.....
• Positive and Normative
– Positive economics: “what is” in economic matters
• Establishes a cause and effect relationship between
variables.
• Analyzes problems on the basis of facts.
– Normative economics: “what ought to be” in
economic matters.
• Concerned with questions involving value
judgments.
• Incorporates value judgments about what the
economy should be like.
• Eg: India needs to grow at 9% to achieve PM
Modi’s target of $5 trillion economy 35
 Types
• Short of Economic Analysis....
Run and Long Run
– Short run: Time period not enough for consumers and
producers to adjust completely to any new situation.
• Some inputs are fixed and others are variable
– Long run: Time period long enough for consumers and
producers to adjust to any new situation.
• All inputs are variable
• Decisions to adjust capacity, to introduce a larger
plant or continue with the existing one, to change
product lines.
In terms of accounting or finance:
short run- any time period less than a year
Long run- 5 to 6 years or even as high as 20 years
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 Types of Economic Analysis....
• Partial and General Equilibrium
– Partial equilibrium analysis: Related to micro
analysis
• Studies the outcome of any policy action in a
single market only.
• Equilibrium of one firm or few firms and not
necessarily the industry or economy.
– General equilibrium: Explains economic
phenomena in an economy as a whole.
• State in which all the industries in an economy
are in equilibrium.
• State of full employment

37
 Economic Decisions/Questions
The fundamental problem faced by economy :

• WHAT to produce? (make) - Choice

• HOW to Produce?(manufacture) - efficiency
• FOR WHOM to Produce? (who gets what) -
distribution
• Are Resources used economically? – scarcity
• Are resources fully employed?
• Is the economy growing?

The way these questions are answered, determines the

economic system
38
 Economic Principles Relevant to
Managerial Decisions
• Concept of scarcity
– Unlimited human wants
– Limited resources available to satisfy such wants
– Best possible use of resources to get:
• maximum satisfaction (from the point of view of
consumers) or
• maximum output (from the point of view of producers or
firms)
• Concept of opportunity cost
– Opportunity cost is the benefit forgone from the alternative
that is not selected.
– Highlights the capacity of one resource to satisfy multitude of
wants
– Helps in making rational choices in all aspects of business,
since resources are scarce and wants are unlimited
– Masses vs Classes
39
 Economic Principles Relevant to
Managerial Decisions ….
• Concept of margin or increment
– Marginality: a unit increase in cost or revenue or utility.
• Marginal cost: change in Total Cost due to a unit change in output.
MC = TCn – TCn-1
Marginal cost = (Change on total cost)/change in total output
= dTC/ dQ
• Marginal revenue: change in Total Revenue due to a unit change in
sales.
• Marginal utility: change in Total Utility due to a unit change in
consumption.
– Incremental: applied when the changes are in bulk, say 10% increase in
sales.
– An increase in the sales of a firm due to introduction of online selling and
additional costs of launching the online selling mechanism would be
termed as “incremental revenue” and “incremental costs” respectively.

40
 Economic Principles Relevant to Managerial
Decisions…
• Discounting Principle
– Time value of money : Value of money depreciates with
time
• A rupee in hand today is worth more than a rupee
received tomorrow.
– Most business decisions relate to outflow and inflow of
money and resources at different points of time
1
PVF =
(1  r) n

where
PVF = Present Value Factor ,
n = period (year, etc.)
r = rate of discount
41
 Production Possibilities Curve
• Shows the different combinations of the quantities of two goods
that can be produced (or consumed) in an economy at any point
of time.
• Depicts the trade off between any two items produced (or
consumed).
• Highlights the concepts of scarcity and opportunity cost
– Indicates the opportunity cost of increasing one item's production (or
consumption) in terms of the units of the other forgone
– Slope of the curve in absolute terms
• Assumptions
– The economy is operating at full employment.
– Factors of production are fixed in supply; they can however be
reallocated among different uses.
– Technology remains the same.

42
Production Possibilities Curve….

Food

Technically
P Infeasible Area
FP

FQ Q

Productively
Inefficient Area

O
CP CQ Clothing
Figure 1.3: PPC for the Society
43
 Production Possibilities Curve….
• All points on the PPC (like P and Q) are points of maximum
productive efficiency.
• In the figure, OFp of food and OCp of clothing can be produced
at Point P and OFQ of food and OCQ respectively at point Q,
when production is run efficiently.
• All points inside the frontier are feasible but productively
inefficient.
• All points to the right of (or above) the curve are technically
impossible (or cannot be sustained for long).
• A move from P to Q indicates an increase in the units of
clothing produced and vice versa.
• It also implies a decrease in the units of food produced. This
decrease in the units of food is the opportunity cost of
producing more clothing.

44
Demand and supply analysis

45
 Demand
“If you can’t pay for a thing, don’t buy it. If you can’t get paid for it, don’t
sell it” (Benjamin Franklin)
 The process to satisfy human wants/ needs/desires – Demand
 Desire: an aspiration to acquire something
 Want: having a strong desire for something
 Demand: effective desire
Demand is that desire which is backed by willingness and ability
to buy a particular commodity, at a given point of time.
Quantity of the commodity which consumers are willing to buy at a
given price for a particular unit of time.
 Things necessary for demand:
 Time
 Price of the commodity
 Amount (or quantity) of the commodity consumers are willing to
purchase at the price
46
 Types of Demand
 Direct and Derived Demand
 Direct demand is for the goods as they are such as
Consumer goods
 Derived demand is for the goods which are
demanded to produce some other commodities; e.g.
Capital goods
 Recurring and Replacement Demand
 Recurring demand is for goods which are
consumed at frequent intervals such as food items,
clothes.
 Durables are purchased to be used for a long period
of time (cars, watches, bikes, mobile phones)
 Wear and tear over time needs replacement
47
 Types of Demand….
 Complementary and Competing Demand
 Some goods are jointly demanded hence are
complementary in nature, e.g. software and hardware, car
and petrol.
 Some goods compete with each other for demand because
they are substitutes to each other, e.g. soft drinks and
juices.
 Individual & Market Demand
 Demand for an individual consumer is Individual demand.
Eg. Your demand for Nissan Kicks.
 Demand by all the consumers for the product know as
Market demand. Eg. Demand for Nissan Kicks in 2019.
 Industry demand is the demand for the product by all firms
in the industry. Eg. Demand for car in year 2019 in India
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 Determinants of Demand
 Price of the product
 Single most important determinant
 Negative effect on demand
 Higher the price-lower the demand
 Income of the consumer
 Normal goods: demand increases with increase in consumer’s
income
 Inferior goods: demand falls as income rises
 Price of related goods
 Substitutes
 If the price of a commodity increases, demand for its
substitute rises.
 Complements
 If the price of a commodity increases, quantity demanded
of its complement falls.
49
 Determinants of Demand….
 Tastes and preferences
 Very significant in case of consumer goods
 Expectation of future price changes
 Gives rise to tendency of hoarding of durable goods
 Population
 Size, composition and distribution of population will
influence demand
 Advertising
 Very important in case of competitive markets
 Growth of Economy
 If economy is growing, demand for goods of better
quality will be high.
 Consumer credit
 Easy access to loans for purchasing consumer goods 50
 Demand Function
 Interdependence between demand for a product and its
determinants can be shown in a mathematical functional
form
 Dx = f(Px, Y, Py, T, A, Ef, N)
 Independent variables: Px, Y, Py, T, A, N
 Dependent variable: Dx
 Px: Price of x
 Y: Income of consumer
 Py: Price of other commodity
 T: Taste and preference of consumer
 A: Advertisement
 Ef: Future expectations
 N: Macro variable like inflation, population growth, economic
growth
51
 Law of Demand
 A special case of demand function which shows relation between
price and demand of the commodity
Dx = f(Px)
 Other things remaining constant, when the price of a commodity
rises, the demand for that commodity falls or when the price of a
commodity falls, the demand for that commodity rises.
 Price bears a negative relationship with demand
 Reasons
 Prize effect – Multiple uses (milk, coal, steel)
 Substitution Effect : When the price of a commodity falls (rises),
its substitutes become more (less) expensive assuming their
price has not changed.
 Income Effect: When the price of a particular commodity falls,
the consumer’s real income rises, hence the purchasing power of
the individual rises.
 Law of Diminishing Marginal Utility: as a person consumes
successive units of a commodity, the utility derived from every
next unit (marginal unit) falls. 52
 Demand Schedule and Individual
Demand Curve

Point on e

Price of Coffee [Rs per cup]

Demand Price (Rs Demand
Curve per cup) (‘000 cups) 35
d
a 15 50 30
b 20 40 c
c 25 30 25
b
d 30 20 20
e 35 10 a
15

O
10 20 30 40 50
Quantity of coffee

53
 Change in Demand

 Shift in demand curve from D to

0

Price D1 D1
 More is demanded at same price.
D0 
D2
Increase in demand caused by:
 A rise in the price of a
substitute
 A fall in the price of a
complement
 A rise in income
 A redistribution of income
towards those who favour the
commodity
 A change in tastes that
favours the commodity
0  Shift in demand curve from D0 to
Quantity
D2
 Less is demanded at each price.
54
 Movements Along and Shifts of The
Demand Curve
Price
Entire demand curve shifts
rightward when:
• income or wealth ↑
• price of substitute ↑
• price of complement ↓
• population ↑
• expected price ↑
• tastes shift toward ↑

D2
D1

Quantity

55
 Movements Along and Shifts of The
Demand Curve
Price
Entire demand curve shifts
leftward when:
• income or wealth ↓
• price of substitute ↓
• price of complement ↑
• population ↓
• expected price ↓
• tastes shift toward ↓

D1
D2

Quantity

56
 Exceptions to the Law of Demand
Law of demand may not operate due to the following reasons:
 Giffen Goods – meat & bread case (Ireland case) Rice (inferior
goods)
 Snob Appeal - Diamond
 Demonstration Effect - items of luxury, fashion
 Future Expectation of Prices (Panic buying)
 Goods with No Substitutes
 Life saving drugs, petrol and diesel
 Insignificant proportion of income spent
 Match box, Salt
57
 Market Demand

 Market: interaction between sellers and buyers of a good (or

service) at a mutually agreed upon price.
 Market demand
 Aggregate of individual demands for a commodity at a particular
price per unit of time.
 Sum total of the quantities of a commodity that all buyers in the
market are willing to buy at a given price and at a particular
point of time (ceteris paribus)
 Market demand curve: horizontal summation of individual
demand curves

58
 Supply
• Indicates the quantities of a good or service that the seller
is willing and able to provide at a price, at a given point
of time, other things remaining the same.
• Supply of a product X (Sx) depends upon:
– Price of the product (Px)
– Cost of production (C)
– State of technology (T)
– Government policy regarding taxes and subsidies (G)
– Other factors like number of firms (N)
• Hence the supply function is given as:
Sx = (Px, C, T, G, N)

59
 Law of Supply
 Law of Supply states that other things remaining the same, the
higher the price of a commodity the greater is the quantity supplied.
 Price of the product is revenue to the supplier; therefore higher price
means greater revenue to the supplier and hence greater is the
incentive to supply.
 Supply bears a positive relation to the price of the commodity.

Supply Schedule Supply Curve

Price of Coffee [Rs per cup]

Point on Supply (‘000 35 e
Supply Price (Rs. cups per
Curve Per cup) month) 30
a 15 10 d
25
b 20 20 c
c 25 30 20
b
d 30 45 15
a
e 35 60
0 10 20 30 40 50 60
Quantity of Coffee 60
 Change in Supply
 Shift in the supply curve from S0
to S1
 More is supplied at each price.
S2
Price S0  Increase in supply caused by:
 Improvements in the
S1
technology
 Fall in the price of inputs

 Shift in the supply curve from S0

to S2
 Less is supplied at each price.

 Decrease in supply caused by:

O  A rise in the price of inputs
Quantity
 Change in government policy
(VAT) 61
 Changes in Supply and in Quantity
Supplied
Price Entire supply curve shifts S1
rightward when: S2
• price of input ↓
• price of alternate good ↓
• number of firms ↑
• expected price ↑
• technological advance
• favorable weather

Quantity
62
 Changes in Supply and in Quantity
Supplied
Price
Entire supply curve shifts S2
rightward when: S1
• price of input ↑
• price of alternate good ↑
• number of firms ↓
• expected price ↑
• unfavorable weather

Quantity
63
 Market Equilibrium
 Equilibrium occurs at the price where the quantity demanded and
the quantity supplied are equal to each other.
 For prices below the equilibrium, quantity demanded exceeds
quantity supplied (D>S). Pulling price upward.
 For prices above the equilibrium, quantity demanded is less than
quantity supplied (D<S). Pushing price downward.

Demand
Price S Supply (‘000
(‘000 cups /
Price cups / month)
E (Rs) month)
25
15 10 50
20 15 40
25 30 30
D
O
30 45 15
30 Quantity 35 70 10 64
 Changes in Market Equilibrium
(Shifts in Supply Curve)
 The original point of equilibrium is
at E, the point of intersection of
curves D1 and S1, at price P and
quantity Q Price S0
 An increase in supply shifts the
D1 S1
supply curve to S2.
S2
 Price falls to P2 and quantity rises E0
P0
to Q2, taking the new equilibrium E
P E2
to E2 . S0
P2
 A decrease in supply shifts the S1
supply curve to S0. Price rises to P0 S2 D1
and quantity falls to Q0 taking the O
new equilibrium to E0 Q0 Q Q2 Quantity
 Thus an increase in supply raises
quantity but lowers price, while a
decrease in supply lowers quantity
65
but raises price; demand being
 Changes in Market • The original point of equilibrium is
at E, the point of intersection of
Equilibrium curves D1 and S1, at price P and
(Shifts in Demand Curve) quantity Q
• An increase in demand shifts the
demand curve to D2 .
Price • Price rises to P1 and quantity
D2 rises to Q1 taking the new
S1
D1 equilibrium to E1
D0 • A decrease in demand shifts the
E1
P1 demand curve to D0.
E • Price falls to P* and quantity
P
E2 falls to Q* taking the new
P*
D2
equilibrium to E2.
S1 D0 D1 • Thus, an increase in demand raises
O Q* both price and quantity, while a
Q1 decrease in demand lowers both
Quantity
price and quantity; when supply
remains same.
66
 Change
D
in Both Demand and Supply
2

D1  Whether price will rise, or

Price
S1 remain at the same level, or will
E1 S2
P2
fall, will depend on:
P1 E2  the magnitude of shift and
 the shapes of the demand
and supply curves.
S1 D2  Therefore, an increase in both
S2 D1 supply and demand will cause
O Q1 Q2 Quantity the sales to rise, but the effect on
price can be:
 Positive (D increases more
than S)
 Negative (S increases more
than D)
 No change (increase in
D=increase in S)

67
Introduction to Macro Economics
National Income

68
CIRCULAR FLOW OF ECONOMIC ACTIVITIES AND INCOME

The simple model of the circular flow assumes two players:

Firms (Producer)
• Produce and supply the goods and services by considering the
various factors of production
Households (Consumer)
• Who is an individual who purchase goods and services

 Households provide services in terms of factor inputs to the firms

and get paid for these services by firms which households spend on
consumption.
 Thus Money and economic activities flowing between firms and
households create a circular flow
 It is a circular flow of money or income

69
 Circular Flow of Income
(Two Sector Economy)
(Wages, Rent, Interest and Profits)
Factor Payments / Income
(Y)
Factor Inputs

Savings
(S) Financial Investment (I)
Households Firms
Market

Goods and
Services (O)

Consumption
expenditure
(C)
In the equilibrium Y=E=O 70
 Circular Flow of Economic Activities
and Income
• Value of output produced (Y) = value of output sold (O)
• Value of output sold = Sum of consumption expenditure (C) and
investment expenditure (I).
E = O = C+I
• Income is either consumed or saved (S).
Y = C+S = C+I

• Savings are withdrawal of money from the circular flow

• Investment is injection of money into the circular flow
• For equilibrium savings should be equal to investments
• Hence Y=O=E

71
 Circular Flow of Income
(Four Sector Economy)
The third sector is Government (G)
• Government Spending
– On provision of public utility goods and services.
– Provides salaries to the households
– Pays to firms for purchases of goods and services - public ltd companies
• Government Revenue
– Households and firms pay various taxes and other payments and provide
factor inputs to the government.
– Government borrows from the financial market to fill revenue gap.
The fourth sector is the external sector
• Imports (M): Outflow of income occurs when the domestic firms
buy goods and services from foreign ones.
• Exports (X): Inflow of income takes place when foreign firms buy
goods and services from domestic ones
72
 Circular Flow of Income
(Four Sector Economy)
Government
(G)
Remittances
Taxes Factor Taxes for purchases
Salaries Payments
Factor Inputs

Savings
(S) Financial Market Firms
Households Investment
(I)

Exports Goods
Exports
Consumption
Expenditure

Imports Foreign Nations Imports

(X-M)
73
 Circular Flow of Income
(Four Sector Economy)
• National income includes expenditures on consumption,
investment, government and net of exports (X-M)
National Income=C+I+G+(X-M)
• Since national income can either be consumed, or saved, or paid
as tax to the government:
C+I+G+(X-M)=C+S+T

• Sum of private investment and expenditure on net exports is equal

to the sum of savings and tax revenue. Thus:
I+G+X = S+T+M
• Therefore, W=J
• At equilibrium, total injections are equal to total withdrawals.

74
 Macro-economic Variables
• Aggregate Demand and Aggregate Supply
–Aggregate Demand is the sum of demand for all goods and
services by all the consumers for a given period of time.
• aggregate demand (AD) for consumer goods i.e.
consumption demand (C)
• aggregate demand for capital goods i.e. (I).
Thus AD = C+I
• Aggregate supply is the total national output produced and
supplied by all the factors of production in an economy.
• It refers to the supply of all goods and services in the economy
for a given period of time.
• Aggregate supply (AS) consists of
–supply of consumer goods (C) and
–Supply capital goods (where capital comes from savings (S),
Hence AS=C+S
75
 Macro-economic Variables….
• Stock and Flow
– Stock may be defined as any economic variable which has been
accumulated at a specific point of time
• like money, assets and wealth.
– Flow includes the variables which increase (inflows) and
decrease (outflows) the stock, over a period of time.
• like income, consumption, saving and investment
Stock=Inflows-Outflows
• Intermediate and Final Goods
– Intermediate goods (and services) are items purchased by firms
for using them in production of some other goods or utility.
(Partly finished goods or raw materials)
– Also known as producer goods because they are used as inputs
in the production of other goods.
– Final goods are those which are demanded by the final
consumer for using these goods as they are. 76
 Macro-economic Variables….
• Capital formation
– The process of savings being converted into investment is known as
capital formation
– Gross Capital Formation refers to the aggregate of additions to fixed
assets (Fixed Capital Formation) and increase in stocks of inventories
during a period of time.
• Employment
– An employed person is willing and capable to work in a productive
activity and is engaged for certain number of hours per week, whether
working for self or someone else.
– The population of any country is divided into working population (age
group of 16 to 65 ) and dependents.
• Government Expenditure and Revenue
– Government Expenditure is which is made from public exchequer.
– Government Revenue is income received by government in various
forms, e.g. Taxes 77
 National Income
• National income is defined as the money value of
all the final goods and services produced in an
economy during an accounting period of time,
generally one year.
Concepts of National Income
• Gross Domestic Product (GDP)
• Gross National Product (GNP)
• Net Domestic Product (NDP)
• Net National Product (NNP)
• Per Capita Income

78
 Gross Domestic Product
• Gross Domestic Product (GDP): GDP is the sum of money
values of all final goods and services produced within the
domestic territories of a country during an accounting year. It
includes income from exports and payment made on imports
during the year.
GDP= C+I+G+(X-M)
• GDP at market price: includes the final value of goods and
services also includes indirect taxes and excludes the subsidies
given by the government.
• GDP at factor cost is the money value of final goods and
services based on the cost involved in the process of production.
GDP at factor cost = GDP at Market Prices –Indirect Taxes+

Subsidies
79
GDP -India

80
81
82
83
 Gross National Product
• Gross National Product (GNP): GNP is the
aggregate final output of citizens and businesses of an
economy in a year.
• GNP may be defined as the sum of Gross Domestic
Product and Net Factor Income from Abroad (NFIA).
GNP = GDP + NFIA
GNP = C+I+G+(X-M)+NFIA
• Net Factor Income from Abroad: difference between
income received from abroad for rendering factor
services and income paid towards services rendered by
foreign nationals in the domestic territory of a country.

84
GNP INDIA

85
 Net Domestic Product and
Net National Product
• Net Domestic Product
= GDP-Depreciation
• Net National Product (NNP)
= GDP–Depreciation +NFIA
Or =GNP–Depreciation
• Thus NNP is the actual addition to a year’s wealth and is the sum of
consumption expenditure, government expenditure, net foreign
expenditure, and investment, less depreciation, plus net income
earned from abroad.
= C+I+G+(X–M)–Depreciation + NFIA
• NNP at Factor Cost is the sum total of income earned by all the
people of the nation, within the national boundaries or abroad
• It is also called National Income.
• NNP at Factor Cost = NNP at Market Prices –Indirect Taxes+ Subsidies
86
 Real and Nominal National
Income
• National income estimated at the prevailing prices, is called national
income at current prices or Nominal National Income, or Money
National Income or national income at current prices.
• National income measured on the basis of some fixed price, say price
prevailing at a particular point of time, or by taking a base year, is
known as national income at constant prices, or Real National
Income or national income at constant prices.

Nominal GDP
Real GDP =
GDP deflator
• GDP deflator is the ratio of nominal GDP in a year to real GDP of that
year
• GDP deflator measures the change in prices between the base year and
the current year. 87
88
 Per Capital Income and Personal Income
• Per capita income is the average income of the people
of a country in a particular year.
National Income
Per Capita Income =
Total Population

• Personal income is the total income received by the

individuals of a country from all sources before direct taxes
in one year.
Personal income = National income – undistributed corporate profits-corporate
taxes-social security contributions + Transfer payments +interest on public debt
• Personal Disposable Income(PDI) is the income which can
be spent on consumption by individuals and families.
Personal Disposable Income = Personal Income –
Personal Taxes
89
 Problem
From the following information, calculate GDP at market price,
NNP at factor cost and personal Income and Per Capita Income.

(`Crores)
Net Domestic Product at 25,21,700
market price
Net Indirect Taxes 3,06,087
Net factor Income from -41,842
Abroad
Transfer payments 78,821
Depreciation 33,873
Total Population (million) 987
90
 Methods of measuring national income
• At equilibrium,
Output =Income =expenditure
• There are 3 approaches to the measurement of GDP:
– Product (or Output) Method: National Income by
Industry of Origin
• Final Product Method
• Value Added Method
– Income Method or National Income by Distributive
Shares
– Expenditure Method

91
 Product (or Output) Method
• The market value of all the goods and services produced in the
country by all the firms across all industries are added up
together.
• Process
– The economy is divided on basis of industries, such as
agriculture, fishing, mining and quarrying, large scale
manufacturing, small scale manufacturing, electricity, gas,
etc.
– The physical units of output are interpreted in money terms
– The total values added up. (GDP at market price)
– The indirect taxes are subtracted and the subsidies are
added. (GDP at factor cost)
– Net value is calculated by subtracting depreciation from the
total value (NDP at factor cost).
92
 Limitations of Product Method
• Problem of Double Counting:
– unclear distinction between a final and an
intermediate product.
• Not Applicable to Tertiary/service Sector:
– This method is useful only when output can be
measured in physical terms
• Exclusion of Non Marketed Products
– E.g. outcome of hobby or self consumption
• Self Consumption of Output
– Producer may consume a part of his production.
93
 Income Method
• The net income received by all citizens of a country in a
particular year, i.e. total of net rents, net wages, net interest and
net profits. (GDP at factor cost).
• It is the income earned by the factors of production of a country.
• Add the money sent by the citizens of the nation from abroad
and deduct the payments made to foreign nationals (individuals
and firms) (GNP at factor cost) or Gross National Income
(GNI).
Process:
• Economy is divided on basis of income groups, such as
wage/salary earners, rent earners, profit earners etc.
• Income of all the gruops is added, including income from
abroad and undistributed profits.
• The income earned by foreigners and transfer payments
made in the year are subtracted.
GNI = Rent + Wage + Interest +Profit + Net Income from Abroad-
Transfer payments 94
 Limitations of Income Method

• Exclusion of non monetary income: Ignores the non-

monetized section of economic activities.
– Economic activities that contribute to national income,
but due to their non monetary nature, they go
unrecorded. For e.g. a farmer and family working in
their own field.
• Exclusion of Non Marketed Services: People undertake
a particular activity that are difficult to ascertain in money
value. E.g. mother’s services to the family.

95
 Expenditure Method of Measuring National
Income
• The total expenditure incurred by the society in a particular
year is added together to get that year’s national income.
• Components of Expenditure:
– personal consumption expenditure
– net domestic investment
– government expenditure on goods and services, and
– net foreign investment
Limitations
• Ignores Barter System
• Ignores Own Consumption
• Affected by Inflation

96
 Uses of National Income Data
• National income is the most dependable indicator of a
country’s economic health.
• Difference between GDP and GNP indicates the
contribution of net income earned abroad
• Necessary for Economic planning: useful aid in judging
which sectors should be given more emphasis
• A measure of economic welfare.
– higher aggregate production implies more and more
goods and services being available to people
• Helps in determining the regional disparities, income
inequality and level of poverty in a country.
• Helps in comparing the situations of economic growth
in two different countries. 97
 Difficulties in Measurement of National
Income
• Non monetized transactions: Exchange of goods and services
which have no monetary payments, like services rendered out of
love, courtesy or kindness are difficult to include in the
computation of national income.
• Unorganized sector: Contribution of unorganized sector are
unrecorded. It is very difficult to identify income of those who
do not pay income tax.
• Multiple sources of earnings: Part time activity goes
unrecognized and such income is not included in national
income.
• Categorization of goods and services: In many cases
categorization of goods and services as intermediate and final
product is not very clear.
• Inadequate data: Lack of adequate and reliable data is a major
hurdle to the measurement of national income of underdeveloped
countries. 98
 Money supply aggregates in India
RBI calculates various concepts of money supply which are known
as money supply aggregates or measures of monetary aggregates.
M1: Currency with public, i.e. coins and notes + demand deposits of
public with banks. (very liquid assets)
– It is also known as Narrow Money
M2: M1 + Post office savings deposits
M3: M2 + Term deposits of the public with banks+ “Other” deposits
with RBI
– It is also known as Broad Money.
M4: M3 + All other deposits with Post office
M0: Currency in circulation+ Bankers’ deposits with RBI+ “Other”
deposits with RBI.
– It is also called Reserve Money.
Now RBI calculates only three of the above measures, i.e. M0, M1, and M3.
99
 INFLATION
(causes & controlling)

Inflation Rate ( Nov. 2019) Food Inflation (Nov.2019)

100
 Inflation
• Coulborn: it is a state of “too much money chasing too few goods”.
• Two broad categories:
– price inflation (generally called as inflation)
– money inflation
• Both have cause and effect relationship, i.e. money inflation leads to
price inflation.
– Money inflation is increase in the amount of currency in
circulation. Which may be due to:
• Deficit financing : direct cause is printing of additional currency
on demand of the government to meet its needs.
• Additional money supply through foreign exchange inflows in
the form of capital, such as foreign direct investment(FDI) and
foreign institutional investment(FII), tourism and other incomes
from abroad.
• Price inflation is a persistent increase in the general price level or a
persistent decline in the real income of people, i.e. decline in value of
money.
101
 Concepts of Inflation
• Headline Inflation: measure of the total inflation within an economy
– affected by the areas of the market which may experience sudden
inflationary spikes such as food or energy.
• Hyperinflation: prices increase at such a speed that the value of money
erodes drastically
– This is also known as galloping inflation or runaway inflation.
• Stagflation: a typical situation when stagnation and inflation coexist.
• Suppressed inflation: temporarily keep prices under check - Diesel & petrol
• Disinflation: a process of keeping a check on price rise by deliberate
attempts.
• Deflation: a state when prices fall persistently; just opposite to inflation
• Inflationary Gap (Keynes): Excess of anticipated expenditure over available
output at base price.
– Represents rise in price due to gap between effective supply and demand
– When money income exceeds the supply of goods and services, a gap is
created between demand and supply resulting in inflation.
102
Inflation rate of various countries
Hyper Inflation Deflation

103
 Wage Price Spiral
Wages chase prices and prices chase wages, thus create a wage
price spiral.
• When prices rise, workers
demand higher money (or
nominal) wages to protect
their real wages. This raises Prices Rise
the costs faced by their
employers.
• To protect the real value of Cost of
production rises
profits, producers pass the Cost of
higher costs onto consumers living rises
in the form of higher prices.
• Workers (who are also Wages rise
consumers) demand for
higher money wages.

104
 Causes of Inflation
• Excess Money Supply
• Demand Pull Inflation: when aggregate demand increases due to any
reason, and supply of output is unable to match this increased demand; i.e
demand pulls prices up.
– Increase in money supply/ Increase in disposable income
– Increase in aggregate spending
– Increase in population of the country
• Cost Push Inflation: An increase in price of any of the inputs will
increase the cost of production; i.e. prices pushed up by cost.
• Low Increase in Supply: if supply falls short of demand, prices will
increase.
– Obsolete technology/Deficient machinery
– Scarcity of resources
– Natural calamities/ Industrial disputes/ external aggressions
• Built in Inflation: Built in inflation is a type of inflation that has resulted
from past events and persists in the present.
– It is also known as hangover inflation.
105
 Inflation and Decision Making
• Impact on Consumers
– increase in any price upsets the home budget.
• Impact on Producers (or Suppliers)
– Producers as sellers are benefited by inflation;
• higher the prices, higher are their profits.
– when as buyers of raw material, they are adversely affected by
inflation.
• Impact on Government:
– Government has to take the economy to higher levels of
growth by encouraging production and investment.
– At the other end, has to see that taxpayers’ money is not
eroded by hyperinflation.
– Thus government has to act as the balancing force between
consumers and sellers.
106
 Measuring Inflation
• A price index is a numerical measure designed to
compare how the prices of some class of goods and/or
services, taken as a whole, differ between time periods
or geographical locations. (prices of the base year are
assumed to be equal to 100.)

Current Year' s Price

Price Index = 100
Base Year' s Price

• The most common term used to denote inflation is

inflation rate, which is annual rate of increase of
prices.

Inflation Rate Last year' s Index - Current Year' s Index

 100
Current Year' s Index 107
 Measuring Inflation
• Producer Price Index (PPI): measures average changes in prices
received by domestic producers for their output.
• Wholesale Price Index (WPI): measures wholesale prices of a wide
variety of goods (including consumer and capital goods).
– USA has replaced WPI with PPI
• Consumer Price Index (CPI): measures the price of a selection of
goods purchased by a typical consumer.
– CPI differs from PPI in that price subsidy, profits, and taxes may cause
the amount received by the producer to differ from what the consumer
paid.
• Cost of Living Indices (COLI): used to adjust fixed incomes and
contractual incomes to maintain the real value of such incomes.
– wage indexation is based on such indices.
• Service Price Index (SPI): With the growing importance of service
sector across the world, many countries have started developing services
price indices (SPI).

108
Consumer Price Index (CPI)

109
 Inflation and Employment
• A. W. H. Philips studied the relationship between unemployment
and rate of changes in money wages in UK, taking statistics for a
period from 1862 to 1957.
• Philips postulated that the lower the rate of unemployment, the
higher is the rate of change of wages.
• labours accept jobs at lower pay if they are unemployed and
firms are more willing to hire due to low wages.
• But this effect dissipates as inflation becomes more expected
with workers demanding higher wages and firms being less
willing to hire.
• the objectives of low unemployment and low rate of inflation
may be inconsistent.
• Hence the government must choose between the feasible
combinations of unemployment and inflation.
110
 Philips’ Curve
Δ P/P ΔW/W

8 10

Annual 6 8
Price Annual
Rise % 4 Philips’ 6
Wage
curve 4 Rise %
2

O 2
2 4 6 8 1

Unemploymen
t%
• Demand pull inflation refers to the effects of falling unemployment rates
(rising real national income) in the curve.
• Cost push inflation and built in inflation will lead to shifts in the Phillips
curve.
111
 Control of Inflation
• Inflation erodes the value of money and
discourages savings
• But zero inflation is undesirable
• Need to control inflation
– monetary policy measures (proposed by those
who believed money supply is the major
culprit)
– fiscal policy measures (proposed by Keynes
and his followers).
– Other measures
• The government has to adopt an appropriate
combination of these measures after thorough
examination of the causes of inflation 112
 Monetary Policy Measures
• Increasing the discount rate: The central bank rediscounts
the eligible papers offered by commercial banks. This is also
called bank rate.
• Loans less attractive & deposits more attractive for the public
• Higher reserve ratios:
• Cash Reserve Ratio (CRR) – liquid cash with RBI
• Statutory Liquidity Ratio (SLR)-CASH, GOLD &
SECURITIES
• Open market operations: directly sell government securities
to public and restrain their disposable income.
• Sale of securities takes away money from public and also
reduces credit creation capacity of banks
• Selective credit control: discourages consumption but not
investment eg:sugar market
113
114
 Monetary policy of India
Indicators During Jan 2019 During Dec 2019

Inflation rate 2.19 % 5.54 %

Repo rate 6.5 % 5.15 %

Reverse repo rate 6.25 % 4.90 %

Inter bank rate 6.60% 5.40 %
Banking lending rate 9.45% 8.95- 9.40%
to consumers
Cash Reserve Ratio 4.00% 4.00%
(CRR)
Statutory Liquidity 19.5% 18.5%
Ratio (SLR)
115
 Fiscal Policy Measures
The government may reduce public expenditure or
increase public revenue to keep a check on inflation
• Reducing public expenditure
– When government spends on activities like health,
transport, communication, etc., income of
individuals increases; this in turn increases the
aggregate demand.
– Therefore the reverse will also be true.
• Increasing public revenue
– Major source of government revenue is various
types of taxes
– Increase in income tax leaves less of disposable
income in the hands of consumers 116
 Fiscal Policy Measures (GOI)

Government budget 117

Business Cycles

118
 Business Cycle
 Shows the periodic up and down movements in
economic activities.
 Economic activities measured in terms of
production, employment and income move in a
cyclical manner over a period of time.
 Cyclical movement is characterized by
alternative waves of expansion and contraction.
 Associated with alternate periods of prosperity
and depression.

119
 Characteristics of Business Cycles
 Periodicity
 Wavelike movements in income and employment occur at intervals of
6 to 12 years.
 Gap between two cycles is not regular or predictable with certainty.
 Synchronism
 Impact is all embracing, i.e. large sections of the economy experience
the same phase.
 Happens because of interdependence of various sectors of the
economy.
 Self Reinforcing
 Due to interdependence in the economy, cyclical movements faced by
one sector spread to other sectors in the economy; and from one
economy to other economies.
 Thus the upward swing of the cycle is reinforced for further upward
movement and vice versa.

120
 Phases of Business Cycle
Pea G
GNP Ck D Expansi Four phases:
(%) on G  Expansion, B to C
Expansio
’
n  Peak, (Boom) C to D
Contracti
E F  Contraction D to E
on
G (recession),
Contracti A B
 Trough A to B / EF
on
Troug (depression)
h Time Unit
(years)
• Time gap between two bouts of trough (from B to E) or peaks (from D to G)
can vary between 6 to 12 years.
• For 3 to 5 years, the economy experiences growth, then for another 3 to 5
years, it faces contraction or recession.
• GG’ is the steady growth line, to show that the general trend is that of growth.
121
 Phases of Business Cycle
 Expansion: when all macro economic variables like output,
employment, income and consumption increase.
 Prices move up, money supply increases, self reinforcing
feature of business cycle pushes the economy upward.
 Peak: the highest point of growth; referred to as boom.
 Stage beyond which no further expansion is possible,
 Sees the downward turning point.
 Contraction: means the slowing down process of all economic
activities – Recession (When investment reduces, production
slow down, thus increase of unemployment and reducing income
and consumption)
 Trough/Slump/depression: the lowest ebb of economic cycle.
 Followed by the next turning point in the cycle, when new
growth process starts afresh.
122
 Causes of Business Cycles

Explanations given to explain economic cycles:

 Psychological aspects of entrepreneurs and
consumers, such as moods of optimism and
pessimism.
 Monetary phenomenon like changes in money supply,
rate of interest, etc.
 Economic factors, such as over investment, under
consumption and over savings.
 Shocks in the conditions under which producers
supply goods such as technological breakthroughs.
 Climatic changes such as sunspots that may cause
different moods. 123
 Effects of Business Cycles
During Expansion
 High growth: large investments, increase in employment, income and
expenditure
 Inflation: Increase in investment forces more money supply in the
system, demand for factor inputs increases, hence their prices increase
which increases cost of production. So wages and prices of goods also
increase.
 Severe Competition: Firms resort to large amount of non productive
expenditure on advertisements and publicity.
During Recession
 Unemployment, excessive inventory, below capacity operations and
liquidation of firms.
 Excess inventory: Those firms which had produced in abundance during
expansion phase face the problem of maintaining unsold items.
 Retrenchment: in order to reduce investment, recession phase is marked
by large scale retrenchment.
124
 Controlling Business Cycles
At Firm Level
 Precautionary Measures: to be taken at the time of
expansion
 Investments: deter from investing huge amount of funds
in fixed assets.
 Inventory: should not create large inventory of raw
material or finished goods.
 Products: diversify in different markets and different
products, so that risk is diversified.
 Curative Measures: to be taken at the time of recession
 Pricing: Flexibility should be the right strategy, so that
during recession prices may be adjusted to increase
demand without eating away the margins.

125
 Controlling Business Cycles
At Government Level
 Monetary Measures: Central bank uses methods of credit control.
 Rediscount rate:
 Expansion: increase the rediscount rate to curb money supply
 Recession: reduce the rate to increase money supply.
 Reserve ratios:
 Expansion: the ratios are increased so that banks are left with less cash
to be extended as credit
 Recession: the ratios are decreased so that banks can extend easy
credit.
 Two major reserve ratios are SLR and CRR
 Open market operations:
 Expansion: sells securities and takes away disposable income from
people.
 Recession: buys securities to give more in the hands of people
 Selective credit control:
 Banks are advised to extend credit to certain areas, while restrict to
certain other areas. 126
 Controlling Business Cycles
 Fiscal Measures
 Public expenditure
 Expansion: Government reduces expenditure to curtail
demand
 Recession: Government increases expenditure on various
activities like health, transport, communication, etc., thus
income of individuals increases; this in turn increases
aggregate demand.
 Public revenue
 Expansion: An increase in taxes takes away portion of
people’s money income and thus brings down aggregate
demand.
 Recession: It is desirable that governments reduce taxes.
 An appropriate combination of these measures is adopted after
thorough examination of the causes of business cycles. 127
 References
• “Economics and Management for Engineers”, Complied by
Department of Management Studies, Kongu Engineering
College, McGraw-Hill Education, India, 2013.
• Geetika, Piyali Ghosh and Purba Roy Choudhury, “Managerial
Economics”, 1st Edition, Tata McGraw-Hill, New Delhi, 2008.
• Jain S.P., Narang K.L. and Simi Agrawal, “Accounting for
Management”, 1st Edition, Tata McGraw-Hill, New Delhi,
2009.
• Stanley L. Brue and Campbell R. Mcconnell, “Essentials of
Economics”, Tata McGraw-Hill, New Delhi, 2007.
• Jeff Madura, “Fundamentals of Business”, Cengage Learning
Inc., India, 2007.

128